Shopping Tips

How Dealers Still Make Money, Even When Selling Below Invoice

September 02, 2009

Note: In May, 2010, the terms TrueCost and TrueAverage were simplified to Dealer Cost and Average Paid. Learn Why »

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You might think that if a dealer sells a vehicle below factory invoice, the dealer would lose money on that sale. Unfortunately, it’s not that straightforward. Not only is it possible for dealers to make money on vehicles they sell below factory invoice, but they do it quite often. Confusing terminology and hidden profits obscure how dealers make their money. Now TrueCar eliminates these diversions to expose the facts. There are two primary ways in which dealers make a profit when selling below factory invoice. First, dealer profit does not depend on factory invoice as much as it depends on the dealer’s actual cost. If a vehicle sells above the TrueCost, the dealer will make a profit no matter how much below factory invoice the vehicle sells. In the example below, on average, the HUMMER H2, 4wd 4dr SUT sells well below Factory Invoice but above the TrueCost. The dealer therefore makes a profit on these sales. This begs the question, “How are factory invoice and actual cost different?” Manufacturers help lower dealers’ actual costs by offering dealers cash incentives to sell vehicles. This often results in the actual cost dropping well below factory invoice. Manufacturers most commonly do this to move increasingly unpopular or older vehicles, making room for all-new vehicle launches. These Manufacturer-to-Dealer incentives also allow for lower transaction prices, but not by the full amount of the incentive, which both moves more cars and helps to preserve dealer margins. Knowing the TrueCost price before you enter the dealership is a critical negotiation tool. _ Second, a dealer can actually lose money on a sale, yet still make a profit. How? A dealer does not make money solely on the sale of the vehicle. Dealers also rely on what’s called the “backend” profit resulting from add-on sales within the finance and incentives (F&I) office. These backend profits are generated from the sale of products such as warranty extensions, alarm services, paint protection plans, and so on. In fact, one of the most important sources of profit from the F&I office is the finance reserve, or the mark-up made when a vehicle is financed from the dealer and they sell or refer that loan to a lender. This is why it’s critical to negotiate the lowest purchase price possible before discussing trade-ins, your credit rating, or agreeing to monthly payment ranges. Navigating the F&I experience is very tricky. We will discuss dealer loans and how to handle them in more depth in a future post, so be sure to check back. Transparently Yours, The TrueCar Team